Health care tax creates pain in device industry

The impact of the 2.3 percent excise tax levied on medical devices under the Affordable Care Act could drive some small and startup companies in the Tampa Bay area out of business and increase the cost of health care.

The Florida Medical Manufacturers Consortium estimates this area, particularly Pinellas County, represents about one-third of the state’s medical device economy.

The tax could cause medical manufactures to delay expansion, hiring and innovation plans and discourage entrepreneurs from investing in or starting medical device businesses.

Scheduled to start in 2013, the tax on medical device companies’ revenue is designed to help foot the cost for the law’s expanded health insurance and raise about $29 billion over 10 years.

The 2.3 percent tax is giving birth to a variety of business strategies. Some medical device companies will shift production overseas. Others will use cheaper labor to compensate for money lost to the tax or pass the tax cost on to end users, potentially offsetting the goals of health care reform.

Organizations representing medical device manufacturers cite a recent Ernst & Young study showing the industry makes a profit of 3.5 to 4 percent on sales and contend the tax would eliminate most of the profit for some companies.

“There are two sides to the PR on this,” said Geary Havran, president of NDH Medical Inc. and chair of the Florida Medical Manufacturers Consortium. “Congress says 86 percent of the tax will be paid by the country’s largest manufacturers so we should quit whining. But it’s the small guys that get hurt the worst by it.”

A general rule of thumb in the industry is that a company needs to hit $100 million in revenue before it is profitable, he said, so the tax disproportionately impacts smaller and startup companies not yet making a profit. These companies’ revenue already is not enough to generate profit or to pay corporate taxes, but they still would be liable for the excise tax on their revenue.

Havran’s St. Petersburg company, which has 10 employees, is a contract medical device manufacturer specializing in custom extrusions.

For NDH, the tax means the company will be rewriting its supply agreements to identify who is responsible for paying the tax.

“Our objective is to avoid being liable for the tax,” Havran said. “There’s a certain amount of confusion over who is going to pay it and how it will be implemented.”

The Internal Revenue Service is responsible for implementation but hasn’t so far drawn “a bright line,” he said. In contract manufacturing, it’s unclear who pays – the original equipment manufacturer or the distributor.

“It seems ripe for the opportunity for double taxation,” Havran said.

Possible strategies

The medical device industry sort of froze in place when the tax was included in the health care reform law. Havran compared it to what happened to the industry for about a year after the 9/11 terrorist attacks, but believes companies now are more focused on trying to develop strategies to deal with the tax.

“We’re all looking at it in many different ways,” said Robert Saron, president of Bovie Medical Corp. in Largo. “We can’t just eat every tax. The truth of the matter is the cost will be passed on as best we can.”

Bovie (NYSE Amex: BVX) manufactures electro-surgical devices and other products, including J-Plasma, a surgical tool that uses helium and an electrical charge to create a plasma stream as it cuts.

The company, which had revenue of $7.44 million in the second quarter, has historically used second-party businesses and distributors to handle sales of its devices. Now Bovie is hiring a direct sales force for J-Plasma.

Saron, too, is still trying to figure out exactly who in the sales chain will be paying the tax.

“Since we sell half our products through distributors, I guess the price has to be raised,” he said. “It depends on what the final IRS ruling is. If we grow less than 2.3 percent, we gotta make it up somehow. Do we send manufacturing overseas to save 2.3 percent? Fortunately for us, we are not on the cusp of not surviving like some other companies that will get hit really hard.”